Restaurant employers beware: Your business may need to pay CPP and EI for employees’ tips and gratuities
As restaurant employees grapple with labour shortages and soaring food costs, a recent decision added another complication to their plates.
The Federal Court of Appeal (FCA) has found that, in certain circumstances, an employer may be required to pay Canada Pension Plan contributions and Employment Insurance premiums on tips and gratuities paid by customers to employees.
In Ristorante a Mano Limited v The Minister of National Revenue (2022 FCA 151), the corporate taxpayer operated a restaurant in Halifax and employed staff to provide table service to its customers.
As is customary in most restaurants, customers often pay gratuities or tips to their servers. Sometimes, gratuities are paid in cash, which are kept by servers without any interaction with their employer, but more frequently, customers pay their bills using an electronic form of payment.
In cases where the electronic payment received by the restaurant includes money that should go to the server, the portion of the tips that customers have paid electronically is paid by the restaurant to the server at the end of the work shift.
In the restaurant industry, different procedures may be used to pay out these monies to servers and other staff. Ristorante a Mano had an established procedure whereby a server would calculate the total amount of tips received electronically and then would subtract cash payments and other deductions, such as money going to kitchen staff, commonly known as “tip-out.” In later years, the employer would deposit these monies, known as due-backs, directly into the servers’ bank accounts from its bank account.
The restaurant did not consider any part of the electronic tips received by servers to be pensionable salary and wages for purposes of the CPP, or insurable earnings for purposes of the EI, hence not including the due-backs as contributory salary and wages or insurable earnings when computing its liability for CPP or EI purposes.
When assessing the corporate entity operating the restaurant for the years 2015 through 2017, the Canada Revenue Agency took a different view and found that in cases like this one, the employer has an obligation to include sums such as the due-backs in computing CPP contributions and EI premiums because these amounts are essentially paid to servers in respect of their employment. The Tax Court of Canada dismissed the appeal of the taxpayer and upheld the assessments (2021 TCC 22). The taxpayer then further appealed to the Federal Court of Appeal (FCA), which again dismissed the appeal and upheld the assessments.
In dismissing the appeal, the FCA explained that the issue is essentially whether or not tips and gratuities can be considered at any point the property of the employer, before the latter transfers them, or the due-backs in the case at hand, to the servers. Ristorante a Mano deposited tips in its bank account where these monies commingled with its other funds. Then, it used funds from its bank account to pay a portion of those electronic tips to the servers. The FCA considered that the employer had been paying the tips to the employees, not the customers. Any sum of money paid to servers, even though it was initially paid by the customer as a tip, was to be considered when calculating contributions owed for CPP and EI.
The FCA referred in its decision to monies that are temporarily in the employer’s possession, but determining what it means to be in possession is still a grey area. The CRA, in its website, seems to suggest that when money is in the possession of an employer for a brief period of time during an employee’s shift, and paid back to the same at the end of said shift, then there is no control of the tip amount or its distribution (CPP/EI Explained – Tips and gratuities). Hence, the monies would not be subject to CPP contributions or EI premiums. However, the FCA appears to be giving a much broader interpretation to the terms “in possession,” encompassing situations where electronic tips are collected throughout the day and monies are paid to an employee at the end of a workday.
Given the findings of the FCA, however, the CRA may change its position moving forward, such that any tips received electronically, as opposed to cash on the table, will be subject to CPP and EI.
This decision may also lead to complex accounting for a business. In the restaurant industry, albeit not as common as in the past, customers still happen to pay in cash. At the end of the shift tips received by an individual server are offset against the cash the same server has received directly for customers in payment for their bills. In a process commonly know as “cash-out,” the server will then either pay money to the restaurant, if they have received more cash than the tips they are entitled to, or receive money from the restaurant, if they have received little to no cash during the same shift.
Technically, it would seem that employers will be only required to pay CPP contributions and EI premiums on the money that has been in their possession, and it is now being transferred to the employee.
It is also important to note that this decision could have far-reaching consequences for businesses other than restaurants. From bars to hair salons, from a spa to your local pet salon, it is custom to leave tips or gratuities to numerous people who provide a wide range of services. The FCA’s interpretation of the law would be applicable to these businesses.
Finally, the CRA did not assess the appellant on other amounts, such as tip-outs, which is the sum that servers take from their tips and pay to other staff members, such as people working in the kitchen. The Court declined to consider the treatment of tips more broadly, although both the appellant and the CRA wished that more clarity be brought to this issue. Every particular case will likely be decided based on whether or not the amount of money is paid by the employer to the employee in respect of their employment.
The next sections offer more in-depth explanations about the rules applicable to tips and gratuities and the particulars of the FCA’s decision in Ristorante a Mano Limited v The Minister of National Revenue.
Both the CPP and EI regimes require employers and employees to make payments based on the employee's earnings from the employer, and subject to a maximum annual amount per employee. The employer’s contribution under the CPP is determined, in accordance with section 9(1) of the CPP, by applying a contribution rate to “contributory salary and wages” paid by the employer to the employee, less certain deductions.
Under sections 67 and 68 of the Employment Insurance Act, the employer's premium is a multiple of the employee's premium, which in turn is based on the employee's “insurable earnings,” Insurable earnings are defined in section 2(1) of the Insurable Earnings and Collection of Premiums Regulations as “the total of all amounts, received or enjoyed by the insured person [i.e., employee] that are paid to the [employee] by the...employer in respect of that [insurable] employment.”
The CRA’s Position
The CRA has always considered, for purposes of the Income Tax Act, that tips and gratuities received by employees are income earned in respect of employment. However, when it comes to determining whether the same tips received during employment should be considered pensionable earnings under the CPP, insurable earnings under the Employment Insurance Act, or both, the CRA has always used the distinction between tips that have been paid by the employer (controlled tips), or that have been paid by the client (direct tips).
A controlled tip is a sum of money that has come into an employer’s possession, who then pays it to employees. A mandatory service charge to a client's bill to cover tips is an example of a controlled tip. Another common example is the instance where tips are allocated to employees using a tip-sharing formula determined by the employer.
Direct tips are instead paid directly by the customer to the employee. This includes instances where the employer is a mere conduct for the tip, receiving it when the customer pays the bill by debit or credit card but then returning the amount in cash to the employee at the end of the shift. In these instances, the money received by the employee is not subject to CPP contributions or EI premiums.
(For further information see: CPP/EI Explained – Tips and gratuities)
At the Tax Court, Ristorante a Mano based its position on the fact that the money for tips or gratuities never became its property and that it simply transferred the tips received to the employees. Simply put, the appellant stated that it never paid due-backs in respect of a server's employment and therefore these monies could not be equated to insurable earnings. Due-backs had no correlation to the hours worked, or an employee’s sales. The only reason it paid these monies to a server was that a customer had paid their bill using an electronic form of payment.
The appellant further argued that there was a difference between situations where an employer would receive all the tips and then decide how to distribute them among the employees and instances where the employer would simply convert the electronic tips into cash and paid the cash over to the employees. This latter line of cases would not cause an employer to be liable for CPP and EI payments.
The FCA disagreed with these arguments and found that the tips became the property of the employer before the latter transferred the due-backs to the servers. First, the tips were deposited in the restaurant’s bank account and commingled with its other funds. Subsequently, the restaurant used funds from its bank account to pay a portion of those electronic tips to the servers. It was the employer who had been paying the tips to the employees, rather than the customer. Hence, any sum of money paid to servers, even though it was paid by the customer as a tip, was to be considered when calculating contributions owed for CPP and EI.
The FCA further found that the word “paid” in both definitions of “contributory salary and wages” under the CPP and “insurable earnings” under the EI was to be interpreted broadly. For instance, insurable earnings refer to a sum paid to employees in respect of their employment. Previous decisions, including from the Supreme Court (Nowegijick v. The Queen,  1 SCR 29), found that the words “in respect of” have wide scope and import.
To this, the FCA agreed that “but for” their employment as servers by the appellant, the servers would not receive any tips paid to them. Furthermore, the Supreme Court in Canadian Pacific Ltd. v. Canada,  1 S.C.R. 678, already established that an employee’s remuneration could include tips paid to the employer for distribution to its employees. As the FCA pointed out, the Supreme Court also gave a broad interpretation to the word “paid”, saying that “the word ‘paid’...can equally well mean mere distribution by the employer or payment of a debt owing by him” and that “if one gives the word ‘remuneration’ a broad meaning, one must also give a broad meaning to the word ‘paid’.”
In response to the various arguments raised by the appellant, the FCA additionally stated that factors such as when the tips are paid to the servers, how the amounts are divided among employees and later paid, are irrelevant. Rather, in each individual case a Court must consider the facts and determine whether the employer paid the amounts to the employees in respect of their employment.
The FCA drew a distinction between this case and a prior decision from 2007 involving Lake City Casinos Limited (2007 FCA 100), as in the case of Lake City, the Tax Court found that the tips had never been the property, or commingled with the property, of the employer.